10/14/2009 @ 2:23PM

JPMorgan Waves Caution Flag

Despite wowing investors with better than expected third-quarter profits of $3.6 billion, the chief executive praised for steering
JPMorgan Chase
through the credit crisis relatively unscathed stopped short of saying the worst is over, even though that’s precisely what investors want to hear.

Credit costs are rising, including areas previously thought of as “safe”: mortgage loans made to consumers with good credit. JPMorgan set aside another $2 billion for consumer loan losses, and across the company, $32 billion is now on reserve for losses, equaling about 5.3% of outstanding loans.

Losses from prime mortgages, subprime mortgages and home equity will inch up in the coming months. Credit cards, which make up nearly 20% of JPMorgan’s revenues, will see loss rates around 10% of loans, about in line with expected unemployment trends. Additional reserves may have to be put aside depending on where unemployment heads next year.

“While we are seeing some initial signs of consumer credit stability, we are not yet certain that this trend will continue,” Dimon said Wednesday.

Michael Cavanaugh, JPMorgan’s chief financial officer, said they can’t say when exactly they will have to stop building reserves.

Investment banking helped propel profits during the quarter, particularly from a strong showing in bond trading and other fixed-income activities. Revenues from investment banking reached $7.5 billion, up 85% from the third quarter last year. Of that, $5 billion was from fixed-income areas. Profits in the group were $1.9 billion, making up 52% of total profits.

But executives said over the coming months, investment banking results would “normalize,” which is to say they will probably not stay at unsustainably high levels. Future quarters will have to depend more on growth in traditional retail and commercial banking and asset management as well as the release of excess reserves several quarters from now as the economy recovers.

JPMorgan sets the tone for other banks due to report this week and next, including
Goldman Sachs
,
Citigroup
and
Bank of America
this week. Goldman is also expected to report strong results (the current consensus estimate has them at $2 billion for the quarter, though analysts thought the same of JPMorgan). Bank of America and Citi are projected to post losses for the period.

The plight of regional banks is also in question. Many are expected to report profits that are lower than last year’s third quarter, with some in the red. These companies tend to be more exposed to local lending and have less diverse businesses to counter the effects of cyclical trends. Consumer credit losses have yet to peak, and with joblessness on the rise, losses from credit cards and auto loans are seen worsening into next year. Losses from commercial real estate loans, a staple of many regional banks’ businesses, are expected to begin hitting hard.

Analysts at CreditSights said earlier this week the banking sector may merely have entered the eye of the credit crisis hurricane, with more lashings to come. “Now while in the eye [of the hurricane] the bank environment seems tranquil, with the associated bank rallies, but there continues to be a host of naysayers worrying about the next round of credit destruction.”